The Insurance Scandal: Just How Rotten?

The insurance industry is the latest financial sector to have its darkest secrets exposed to the light.

Presumably Marsh’s board is gearing up to make big changes — Mr. Spitzer says he will not settle charges with the current top team. Shrewdly, on October 15th Marsh appointed Michael Cherkasky as the group’s new boss. He recently led Kroll, Marsh’s corporate-investigation subsidiary, previously part-owned by AIG. In the distant past, Mr. Cherkasky did a stint supervising a young Mr. Spitzer in the Manhattan district attorney’s office.

But even if only some of today’s top management survives, Marsh is badly bruised. It has suspended taking any contingent commissions, and revealed that these amounted to $845 million last year, 7 percent of revenues but, more tellingly, one-third of its pre-tax profits. It might have to give all of that back. And anything short of a victory in court will trigger a large fine.

AIG has also been battered. The scandal comes on top of investigations by both the Securities and Exchange Commission and the Justice Department for work it did structuring off-balance-sheet entities for PNC Bank and possibly other companies as well. In a conference call with analysts, Mr. Greenberg said the loss of contingent commissions would have no business consequences, but that seems naive coming from one so experienced. Losing access to a price-rigging cartel can surely only increase competition.

Inevitably, this will affect other insurers, putting structural pressure on prices just as cyclical factors suggest rates are softening. And still unclear is what sort of broad resolution Mr. Spitzer might seek. In prior investigations, his style has been to use the threat of litigation to force through agreements that include lots of money, carefully scripted non-confessions of guilt, and widely trumpeted vows of reform. The results have often been disappointing. It is probably no coincidence that agreements with investment banks and mutual funds have resulted in money moving to less-regulated areas, namely private equity and hedge funds. Insurance more than perhaps any other industry is global, so an inappropriate move by Mr. Spitzer would surely send business overseas.

Europe Looks On

But might the rot have already spread overseas? For the moment European insurers are on the periphery of the American scandal. Only Germany’s Munich Re, the world’s biggest reinsurer, and Zurich Financial Services, a Swiss insurer, were mentioned in Mr. Spitzer’s complaint and neither is accused of any wrongdoing.

Further, Europe does not have an equivalent of Mr. Spitzer, and regulators in Europe are not currently intending to investigate relations between insurers and brokers. So only European insurers with a presence in America risk being directly involved in the scandal for the moment. Swiss Re writes 40 percent of its property and casualty business in America, although only 20 percent of these contracts are done via brokers. A similar portion of Zurich Financial Services’ non-life policies are written in America, mostly directed through brokers.

All the same, European financial markets reacted nervously, and shares in Munich Re, Allianz and AXA all fell. The unknown factor is whether Europeans have also been corrupt. After all, the temptation facing brokers is the same everywhere. Like their American counterparts, European insurers pay brokers contingent commissions. Brokers also demand that insurers provide reinsurance work in exchange for referrals. Criticisms of these practices used to fall on deaf ears. “We consider contingency fees an aberration and we have been asking brokers since 1998 to abolish them,” says Thierry van Santen, head of the Federation of European Risk Management Associations in Brussels.


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